Written by Steven Hansen
The economy did not fall of a cliff in July. It turns out it was not great either. The July 2012 Chicago Fed National Activity Index (CFNAI) release shows the 3 month moving average declined marginally but has remained for the last 5 months in negative territory – indicating national economic activity was moderately below its historical trend.
The index’s short term trend is flat – meaning the economy does not seem to be getting any better or worse. Since the end of the Great Recession, the current values are on the lower end of the channel. The Chicago Fed National Activity Index (CFNAI) provides a summary quantitative value for all the economic data being released. However, this index IS not accurate in real time (see caveats below) – and it did miss the start of the 2007 recession.
This index is a rear view mirror of the economy, and whilst the tend is clearly negative – the index is telling that the economy did expand in July – but that the expansion was under the potential of the economy.
A zero value for the index indicates that the national economy is expanding at its historical trend rate of growth, and that a level below -0.7 would be indicating a recession was likely underway. Econintersect uses the three month trend because the index is very noisy (volatile).
CFNAI Three Month Moving Average (blue line) with Historical Recession Line (red line)
The index was in an improvement trend from November 2011 through February 2012. This index is degrading, but the June data ended 4 straight months of contraction.
CFNAI Three Month Moving Average Showing Month-over-Month Change
This is a super coincident indicator – which by definition is a rear view economic picture.
The CFNAI is a weighted average of 85 indicators drawn from four broad categories of data: 1) production and income; 2) employment, unemployment, and hours; 3) personal consumption and housing; and 4) sales, orders, and inventories.
CFNAI Components – Production & Income (orange line), Employment / Unemployment & Hours (green line), Personal Consumption & Housing (blue line), and Sales / Orders & Inventory (red line)
Low Personal Consumption has been a headwind on the index for the last year. Over the last 4 month, the other three elements of the CFNAI have taken turns dragging the index down. The Chicago Fed’s explanation of the movement this month:
The contribution from production-related indicators to the CFNAI increased to +0.12 in July from +0.01 in June. Total industrial production rose 0.6 percent in July after increasing 0.1 percent in June, and production of durable consumer goods rose 1.5 percent in July after edging up 0.1 percent in the previous month.
The contribution from the consumption and housing category to the CFNAI also increased in July, moving up to –0.22 from –0.28 in June. Housing starts decreased slightly to 746,000 annualized units in July from 754,000 in June, but housing permits rose to 812,000 annualized units from 760,000 over the same period. The contribution from the sales, orders, and inventories category to the CFNAI was also higher in July, increasing to –0.01 from –0.09 in June.
The contribution from employment-related indicators to the CFNAI decreased in July, moving down to –0.03 from +0.02 in June. Civilian employment decreased by 0.1 percent in July after increasing by a similar amount in June, and the unemployment rate inched up to 8.3 percent in July after holding steady in June.
The CFNAI was constructed using data available as of August 17, 2012. At that time, July data for 51 of the 85 indicators had been published. For all missing data, estimates were used in constructing the index. The June monthly index was revised to –0.34 from an initial estimate of –0.15. Revisions to the monthly index can be attributed to two main factors: revisions in previously published data and differences between the estimates of previously unavailable data and subsequently published data. The revision to the June monthly index was due primarily to the former.
The CFNAI explained:
With the significant amount of monthly backward revisions occurring, the three month moving average provides a better metric for economic activity levels.
Econintersect considers the CFNAI one of the best single metrics to gauge the real economic activity for the U.S. – and puts the entire month’s economic releases into their proper perspective, although it is almost a month after the fact. It correlates well and historically has lead GDP – however its correlation post 2007 recession (New Normal) is uncertain. [graph below updated through May 2012 CFNAI]
As the CFNAI is a summary index, the data must be assumed correct to give it credibility. This assumption has been justified in the past because the index has proven to have a good correlation to the overall economy. When using this index, it is trend direction which is important – not necessarily the value when the index is above -0.7, the historical boundary between expansion and contraction.
Caveats on the Use of the Chicago Fed National Activity Index
The index is quite noisy, and the only way to view the data is to use the 3 month moving average. As this index is never set in concrete, each month a good portion (usually from January 2001 onwards) of the data is backwardly revised slightly. The most significant revision is in the data released in the last six months due to revisions of the 85 indices which are embodied into the CFNAI.
Even the 3 month moving average has over time significant backward revision. This is due both to changing methodology and backward revisions of this index’s data sources. This point is important as the authors of this index have stated that -0.7 value is the separation between economic expansion and contraction. The graph below shows the difference between the original published index values and the values of the index as of August 2011.
This index seems to continuously creep – and when using this index in real time, Econintersect would assume the index values when first released could easily be off in a range +0.2 to -0.2 as the data in the future will be continuously revised. However, there are times when the uncertainty in real time can be much larger. For seven consecutive months in the Great Recession, backward revisions ranged from -0.7 to -0.9. In such times of severe economic stress the CFNAI has little real time accuracy, although it still definitely was showing that the economy was bad. It simply did not reflect exactly how bad in real time.
We can compare the CFNAI to ECRI’s coincident index which is released monthly almost in real time. It is true that using ECRI’s coincident index, the year-over-year rate of change is at recession levels – however, the CFNAI’s rate of change provides a different conclusion.
In real time, ECRI’s coincident indicator may be providing a better yardstick for the Wall Street economy. While in hindsight, CFNAI seems more intuitive – but is inaccurate in real time because of backward revision. GDP lives in its own world (as opposed to what economy is experienced by the population in their own lives) and has general correlation to most broad forecasts or coincident indexes as a selected view of the overall economy. However, I do not believe GDP has a good correlation to the Main Street economy.